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A SPECIAL SECTION:  Haiti since the January 12, 2010 Earthquake
                                                         
Posted September 9, 2010
                                       
The Bush Tax Cuts: A Slight Reprieve?
                                                   
Washington, DC - HOW dramatically the pendulum of fear has swung in the past year-from worries about the fragile recovery, to panic about the level of the national debt, and back to anxiety about growth again. Swinging along with it has been the fate of George Bush's tax cuts, which are due to expire at the end of this year. Democratic Party leaders had hoped to make political capital, just before the mid-term elections in November, from the extension of the cuts for households earning less than $250,000 ($200,000 for single earners). At the same time, they hoped to paint the Republicans as hypocrites for moaning about the deficit while fighting to keep low taxes for the very rich. But these hopes, like the recovery, have withered away.

The tax cuts, which were supposed to last for only ten years, had their genesis in the 2000 presidential campaign, when both Mr Bush and Al Gore, the Democratic candidate, proposed to return a portion of the then budget surplus to voters. As the economy tipped into recession in 2001, stimulus became the rationale for the cuts, and for the 2003 law that phased them in more rapidly than originally planned. By then, reduced tax revenues were contributing to a steady increase in the deficit. The Congressional Budget Office has estimated the cost of the cuts over the ten years to 2011 at $1.7 trillion.

Their approaching end might therefore have pleased deficit hawks. The CBO's "baseline" budget forecast, which assumes that the cuts do indeed expire as planned, sees the deficit falling from 9.1% of GDP in 2010 to 2.5% in 2014. A full extension of the Bush tax cuts would increase the shortfall in 2014 to 4.1% of GDP (see chart) and would produce a total budgetary cost of $3.3 trillion over the next decade. That seems completely unaffordable.

But red ink is no longer the main concern in Washington. In July Barack Obama proposed the renewal of cuts for all but the wealthy-an exception that would save perhaps $700 billion over the next ten years compared with a full extension. But disappointing economic numbers have altered the political terrain. A growing number of Democrats have warmed to a full extension, fearful of campaign ads accusing them of raising taxes when the economy is weak. Some form of extension of the cuts for most households does seem prudent. America's economy can ill afford a big fiscal blow. A return to recession is still unlikely, but the odds of one have recently increased. Tax changes aside, fiscal policy will in effect tighten substantially anyway next year, with the end of the two-year stimulus programme and continued belt-tightening at the state and local-government levels. If legislative deadlock adds to this an unintended tax hike, the impact could be dire.

But another ten-year extension is too mighty a weapon to wield against recession, just as no extension at all is a dangerous way to attack the deficit at present. America can, in fact, afford to provide more fiscal support for its economy. But in order to reduce the risk of a debt crisis, Congress should at the same time lay out a credible path back to sustainable budgets, and this it is failing to do. It might have used the opportunity provided by the end of the Bush tax cuts to embark on a long-overdue reform of the tax code, broadening the tax base and making the system simpler and more efficient. Instead, the wrangling is only providing more evidence of Washington's political sclerosis as the economy continues to weaken.

Copyright © The Economist Newspaper Limited 2010. Published Thursday, September 2, 2010.
                                             
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